In this article, we examine the effects of financial statement comparability on the cash positions of U.S. firms. If comparable financial statements can reduce information asymmetry between firms and investors, a positive relationship between financial statement comparability and firms' cash positions would be expected. A negative relationship between financial statement comparability and firms' cash positions can also be explained from the perspective of agency theory.
We further document that the effect of financial statement comparability on cash holdings is mediated by financing constraints, financial reporting quality, and corporate governance. First, we enrich the accounting-finance interface by documenting a robust effect of financial statement comparability on firms' cash positions. However, a high (low) level of financing constraints does not necessarily imply a high (low) level of cash positions.
The mediating effect of financial reporting quality on the relationship between comparability and cash holdings is therefore not clear in advance. H2C: Corporate governance, as mediated by institutional ownership, mediates the effect of comparability of financial statements on corporate cash holdings.
Research design 1 Empirical model
14 on the preliminary motives for holding cash, cash represents a valuable source of investment funds for business growth opportunities during a period of economic uncertainty (Ahrends et al., 2016). 15 Opler et al., 1999).1 The main independent variable is comparability of financial statements (COM), which follows the comparability score developed by De Franco et al. We include a set of control variables related to the determinants of cash holdings.
Cash holdings are lower for larger firms (SIZE) due to economies of scale and, therefore, a negative coefficient is expected. Research and development expenditures (R&D/ASSET) are included to control for growth opportunities and financial distress costs, consistent with Opler et al. We include industry SIGMA, measured as the standard deviation of OCF over the last 3 years for firms in the same industry, as defined by the 2-digit SIC code, in order to control for cash flow riskiness and expect firms with riskier cash flows to hold more money (Opler et al., 1999).
DAC| is the quality of financial reporting determined by the performance-adjusted discretionary accruals (DAC) model developed by Kothari et al. To estimate the DAC, we use the cross-sectionally modified Jones model, controlling for business performance (Dechow et al., 1995; Kothari et al., 2005). We use the absolute value and predict a positive relationship implying that firms with poor quality earnings hold more cash (Sun et al., 2012).
The presence of COM in equation (2) allows for the possibility that COM may have a direct effect on cash holdings. To measure the accounting function of an individual firm i, in each year, De Franco et al. 2011) perform the following time series regression using firm i's 16 previous quarters of earnings (a proxy for financial statements) and stock returns (a proxy for economic events):. To measure the closeness of the functions between firms i and j, De Franco et al. 2011) use each firm's economic events (proxied by RETURNi or RETURNj) to calculate the estimated earnings using each firm's accounting system parameters ( , , ), respectively.
Consistent with previous literature (e.g., Chen et al., 2015; Kim et al., 2016), we convert the comparability measures into ranks to reduce noise in the estimates.
Sample selection and descriptive statistics
All three measures of comparability are significantly (p<0.001) and negatively correlated with CASH (correlation coefficients range from -0.14 to -0.01). Although only suggestive of the underlying relationship, highly significant negative correlation coefficients indicate that firms with higher financial statement comparability hold less cash. Regarding the correlation between CASH and other control variables, we find that larger firms and firms with more leverage, working capital, cash flows, and dividend payments hold less cash, while firms with future growth potential ( in terms of CAPX and R&D) and volatile cash flows hold more cash.
Furthermore, the correlations between CASH and |DAC| and CASH and FC_SA are positive and significant (at p<0.001) (correlations of 0.26 and 0.19 respectively). 21 correlations between CASH and the control variables are all in the expected direction and thus provide support for the validity of our key measures and constructs.
Regression results
Financial statement comparability and cash holdings: Baseline regression
We obtain qualitatively similar results even when LN_CASH is used as a proxy for cash holdings. Cash holdings are larger for firms with more growth opportunities (CAPX, MB, and R&D) and volatile cash flows, but smaller for large, highly leveraged firms, and for firms with more capital circulating and for firms that pay dividends. The coefficients for COM, COM_4, and COM_10 continue to be negative and significant for both the CASH and LN_CASH versions of cash holdings.
Financial statement comparability and cash holdings: Mediating effects of financial constraints, financial reporting quality, and corporate governance
In model (2), the coefficient for FC_SA is negative and statistically significant (p<0.01), implying that funding constraints reduce corporate cash holdings. When we isolate the direct and indirect effects of comparability on cash holdings, we find that comparability directly reduces cash holdings but indirectly (through FC_SA) increases cash holdings. The Sobel test is significant at the 1% level for all comparability measures (COM, COM_4 and COM_10).
The coefficient for FC_WW is positive and statistically significant (p<0.01), implying that financing constraints increase firms' cash positions. When we isolate the direct and indirect effects of comparability on cash holdings, we find that comparability directly and indirectly reduces cash holdings, although the indirect effect is insignificant for the COM_4 and COM_10 measures of comparability. When FC_DIV is used for the mediation test, untabulated results show that the direct effect of comparability is negative and significant (p<0.01), but that the indirect effect of comparability (via FC_DIV) is positive and significant (p<0.01). 0.05).
Finally, with FC_UR, we find that the direct effect of comparability is negative and significant (p<0.01) but the indirect effect of comparability (through FC_UR) is statistically insignificant. In summary, we find that the direct effect of comparability on cash holdings is negative and statistically significant. However, the indirect effect of comparability through financial constraints is sensitive to the indicators used for financial constraints. 3.
In model (2), the coefficient for |DAC| is positive and statistically significant (p<0.01), which means that bad financial reporting increases the cash holdings of companies. The Sobel test is significant at the 1% level for all comparability measures (COM, COM_4 and COM_10), which means a statistically significant partial mediation effect. When we isolate the direct and indirect effects of comparability on cash holdings, we find that comparability directly reduces cash holdings but indirectly (via CG_INST) increases cash holdings.
The Sobel test is significant at the 5% level for all measures of comparability (COM, COM_4 and COM_10).
Sensitivity analysis and robustness check
- Change analysis
We obtain qualitatively similar results when LN_CASH is used as a measure of cash positions (not tabulated). Moreover, the relationship between comparability and cash holdings is also significantly mediated by financial constraints, financial reporting quality, and corporate governance. It is possible that our analysis omits some other determinants of cash holdings that are correlated with other included variables.
Itzkowitz (2013) shows that firms with a more concentrated customer base hold more cash. 2012) show that institutional shareholdings increase corporate cash holdings. Studies also show that the organizational structure of firms (e.g. Tong, 2011), tax costs associated with repatriations (e.g. Foley et al., 2007) and CEO risk incentives (e.g. Liu and Mauer, 2011) affect corporate cash holdings. Results reported in Panel B of Table 5 show that the effects of accounting comparability (COM, COM_4 and COM_10) on cash holdings (CASH and LN_CASH) remain qualitatively similar in terms of sign, significance and magnitude.
Although our analysis above controls for various firm characteristics that might explain the effects of financial statement comparability on cash holdings, endogeneity arising from reverse causality is always a concern in studies such as this one. 27 statement comparability is driven by a decrease in monetary holdings, then a change in comparability should have a first-order effect on changes in monetary holdings. We find that the estimated effect of comparability on cash holdings (CASH) increases significantly after this procedure.
We obtain qualitatively similar results when LN_CASH is used as a measure of cash positions (results not tabulated). The tabular results suggest that the effects of financial statement comparability on firms' cash positions remain robust even when we use the two-step GMM approach. Our results remain robust even when LN_CASH is used as a measure of cash positions (not tabulated).
In short, results of endogeneity tests provide evidence that our documented negative relationship between comparability and cash holdings is robust, and not driven by an endogeneity problem.
Conclusion
29 Using a large panel of US data, we document that comparability in accounts significantly reduces companies' cash holdings. Our findings confirm that the relationship between financial comparability and firm liquidity is also mediated by financing constraints, financial reporting quality, and corporate governance. These results are robust to alternative specifications of comparability of financial statements and cash holdings and to alternative regression specifications.
Endogeneity is a major concern in this article, as some unobservable factors may affect the comparability of financial statements, and indirectly affect cash holdings. This table reports the regression results of the effects of financial statement comparability on corporate cash holdings (test of H1). Our primary independent variable is financial statement comparability (COM) as in equation (7) of the text.
This table reports the OLS regression results of the effects of financial statement comparability on firms' cash positions (test of H1). This table reports the fixed effect regression results of the effects of financial statement comparability on firms' cash positions, using CASH/TA (cash and marketable securities (CHE) divided by total assets (AT)) as the dependent variable used. The key independent variable is the comparability of financial statements (COM), as in equation (7) of the text.
This table reports the results of fixed effect regression of the effects of the effects of financial statement comparability on corporate cash holdings including additional control variables to mitigate omitted variable bias. This table reports regression results of the effects of financial statement comparability on corporate cash holdings.
